UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM ERASMUS UNVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS GOVERNMENT EXPENDITURE AND HAPPINESS: DIRECT AND INDIRECT EFFECTS BY TUNG K DAO MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, NOVEMBER 2017 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS GOVERNMENT EXPENDITURE AND HAPPINESS: DIRECT AND INDIRECT EFFECTS A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By TUNG K DAO Academic Supervisor: Dr Elissaios Papyrakis Dr Pham Khanh Nam HO CHI MINH CITY, NOVEMBER 2017 Contents List of Tables v List of Appendices vi List of Acronyms vi Abstract vii Chapter 1: Introduction 01 1.1 Background 01 1.2 Research questions and contribution 02 1.3 Scopes and limitations of the study 02 1.4 Data and methodology 03 1.5 Organization of the research paper 03 Chapter 2: Review of Literature 04 2.1 Key concepts 04 2.2 Government expenditure and happiness 05 2.3 Social development and happiness 06 2.4 Other determinants of happiness 07 Chapter 3: Data and Methodology 11 3.1 Data and variable explanation 12 3.2 Methodology 17 iii Chapter 4: Results and Analysis 19 4.1 Findings and interpretation of the basic panel regressions 19 4.2 Findings and interpretation of the transmission channels model 38 Chapter 5: Conclusion 45 References 47 Appendices 51 iv List of Tables Table 3.1 List of variables with description 13 Table 3.2 Descriptive statistics 15 Table 3.3 Correlations between explanatory variables 16 Table 4.1 Direct effect regressions – Pooled OLS model 20 Table 4.2 Direct effect regressions – Fixed Effects model 22 Table 4.3 Direct effect regressions – Random Effects model 24 Table 4.4 Happiness regressions with HDI – Fixed Effects model 29 Table 4.5 Happiness regressions with HDI – Random Effects model 31 Table 4.6 Changes in happiness regressions – Fixed Effects model 33 Table 4.7 Changes in happiness regressions – Random Effects model 35 Table 4.8 Change in happiness (2009-2012) regressions – OLS 40 Table 4.9 Indirect transmission channels 42 Table 4.10 Indirect effect regression 43 Table 4.11 Relative importance of transmission channels 44 v List of Appendices Appendix Breusch-Pagan Lagrange multiplier test result Hausman test result (Happiness regressions) 51 52 Appendix Hausman test result (Changes in Happiness regressions) 53 Appendix Indirect transmission channels with full large sample 54 Appendix List of countries (full sample) 55 Appendix List of countries (sub-sample used in Section 4.2) 58 List of Acronyms GDP : Gross Domestic Product ILO : International Labor Organization OECD : Organization for Economic Co-operation and Development OLS : Ordinary Least Squares The US : The United States of America vi Abstract This research paper aims to investigate the importance and significance of government size on happiness Utilizing a relative large panel sample, which covers 183 countries in a period from 1990 to 2016, the research objective is first to study the direct effect of government expenditure on happiness through basic panel analyses After understanding the importance and significance of government expenditure, this paper then tries to determine the indirect effects of government expenditure on happiness through the transmission channels include income, inequality, unemployment rate, inflation rate, economic growth and social development In order to obtain the research objectives, this paper applies not only panel data regression methodologies, such as Pooled OLS, Fixed Effects, Random Effects Models, but also cross-sectional analysis; and finds that government expenditure only affects happiness in short term and that the importance and direction of the transmission channels are heterogeneous Relevance to Development Studies This research is expected to contribute to the existing literature the evidence of the existence of a linkage between government size and happiness not only in long term but also in short term In addition, the results of this study would shed light on the effects of government expenditure on happiness, both in direct and indirect ways Besides, when performing analyses on the relationship between government expenditure and happiness, this research also provide strong evidences of other drivers of happiness as well as the relative importance of the transmission channels, which could be helpful and useful for further development studies Keywords Government expenditure, public spending, happiness, subjective well-being, transmission channels vii CHAPTER INTRODUCTION 1.1 Background “Economists are trained to infer preferences from observed choices; that is, economists typically watch what people do, rather than listening to what people say Happiness research departs from this tradition” (Di Tella & MacCulloch, 2006, p 25) For a long time, economic researches prefer objective measures of human well-being, such as income per capita, when studying different models of development However, Easterlin (1974) points out that economic growth does not always lead to a raise in life satisfaction, the happiness as a subjective approach has been introduced in many economic research to gain more precise knowledge of human well-being By identifying the determinants of happiness and understanding the dependence of happiness on macroeconomic variables, especially government expenditure, governments could improve their economic and social policies The size and volatility of government spending are believed to have significant effects on the social well-being Higher public spending in fields like education, health, and development could result in higher living standard which means higher happiness level Lower government spending could imply that the government is applying a lower tax rate, which might boost the economic growth that can also lead to an increasing the living standard in the country The effect of government quality on happiness is positive and supported by many empirical researches (Blanchflower & Oswald, 2008; Ott, 2015; Radcliff, 2013) However, divergent impact of government expenditure on welfare is found in different studies using different methods and datasets While Bjørnskov et al (2007) emphasize the drawback of government consumption; Ram (2009) finds no evidence of a negative impact of government expenditure on happiness On the other hand, Perovic and Golem (2010) suggest that public spending and happiness have a non-linear relationship Considering the importance of happiness in the economic and social development, many researchers have been trying to identify significant factors affecting the welfare Previous studies have taken into account numerous factors, such as climate and environment (Rehdanz & Maddison, 2005; Welsch, 2006); culture, gender, and religion (Dorn et al., 2007; Mookerjee & Beron, 2005); as well as macroeconomic components, including governance factors (Di Tella et al., 2003; Ruprah & Luengas, 2011) It is widely agreed that government has significant impacts on happiness However, there are two main conflicting arguments on the consequences of government expenditure 1.2 Research questions and contribution This research paper aims to investigate the importance and significance of government size on happiness Given the vast literature on happiness, there are very limited studies available on various explanatory variables as transmission mechanisms of government expenditure The research objective is first to study the direct effect of government expenditure on happiness through basic panel analyses After understanding the importance and significance of government expenditure, this paper then tries to determine the indirect effects of government expenditure on happiness through the transmission channels include income, inequality, unemployment rate, inflation rate, economic growth and social development Therefore, to achieve these objectives, this research attempts to address following questions: i ii Does government expenditure have direct effect on the level of happiness? Does government expenditure have indirect effects on the level of happiness through the transmission channels? By answering the above questions, this research is expected to contribute to the existing literature the evidence of the existence of a linkage between government size and happiness not only in long term but also in short term In addition, the results of this study would shed light on the effects of government expenditure on happiness, both in direct and indirect ways Moreover, this research introduces the social development dimensions, which are hardly seen in previous happiness studies, along with other macroeconomic factors Besides, when performing analyses on the relationship between government expenditure and happiness, this research also provide strong evidences of other drivers of happiness as well as the relative importance of the transmission channels, which could be helpful and useful for further development research 1.3 Scopes and limitations of the study This research covers 183 countries (see Appendix for list of countries), in a period from 1990 to 2016 (the exact time of available data for happiness includes 1990, 1995, 2000, 2006, 2009, 2012, and 2016) Such sample could be considered relatively large and inclusive However the availability of data is not continuous throughout the period, especially that of happiness, social development data Furthermore, the analysis would have been much deeper, had the different components of public expenditure, e.g., education expenditure, health expenditure, social expenditure, be analyzed 1.4 Data and methodology Data in this research is obtained from various sources To acquire happiness at country level, this research employs the “life satisfaction” data from the Gallup World Poll The data for government expenditure and several macroeconomic happiness determinants namely income, inequality, unemployment rate, inflation rate, and economic growth are acquired from the World Bank’s World Development Indicators dataset In addition, the social development data is obtained from the Indices of Social Development database Analysis in this research paper follows the methodology of Papyrakis and Gerlagh (2004), who study the transmission channels through which natural resource abundance indirectly affects economic growth1 In order to analyze the dependence of happiness on government expenditure, this study conducts regression analysis through the Pooled OLS, Fixed Effect, and Random Effect Models Then model specification tests are employed to identify the most appropriate model for further analyses Next, to investigate the magnitude and significance of the transmission channels, I estimate the effects of government expenditure on income, inequality, unemployment rate, inflation rate, economic growth and social development to capture their indirect effects on happiness 1.5 Organization of the research paper The remaining of this paper is structured as follows Chapter provides the literature review on happiness in the relations with government expenditure and other explanatory variables Chapter explains the data and the econometric methodology employed in addressing the research questions Chapter analyzes the regression results to understand the direct and indirect effects of government expenditure on happiness Chapter concludes the research paper I also review the methodology of Pellegrini and Gerlagh (2004) who study the transmission channels through which corruption affects economic growth In terms of policy implication, this research’s findings suggest that governments should pay strong attention to policies that reduce unemployment rate as unemployment is the largest negative channel through which government expenditure damage happiness In addition, the results of many social development channels, such as Clubs and Associations, Gender Equality, and Inclusion of Minorities, are relatively large which implies that government should increase public spending in social development projects which improve activities of social development associations and organizations; create more opportunities for women in the workplace, education, and family; and boost the inclusion of minor groups It is indisputable that empirical analysis on happiness usually suffers data limitation problems Given the fact that data in this research comes from different sources, of which, the availability of data appears in different years For example, I have to use the 2005 values of social development in the regressions of the 2006 values of happiness, and the same for social development in 2010 and happiness in 2012 Hence, although considering a relatively long period and covering a large number of countries, the actual observations that can be used in the empirical analysis remain relatively small, comparing with the potentially full sample size Therefore, I need to acknowledge that data limitations might, to some extent, hinder the accuracy of the empirical findings I expect that further research on this topic would be able to address the problems of data availability Besides, this research does not divide the main sample into sub-samples based on countries’ characteristics; analyze different parts of government expenditure, such as public spending on health, education, energy and environment, science, military, food and agriculture, transportation, etc This might to a certain extent affect the results So the extension of this study could be investigating different period of time, grouping countries into sub-samples, using different measures of happiness, introduce different portions of government expenditure as well as taking into account different explanatory variables and transmission channels These extensions would provide a more accurate and insightful picture about the relationship between government expenditure and happiness 46 References Alesina, A., Di Tella, R., & MacCulloch, R (2004) Inequality and happiness: are Europeans and Americans different? 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Evidence from surveys of subjective well‐being International finance, 6(1), 1-26 50 Appendix Breusch-Pagan Lagrange multiplier test result quietly xtreg Happiness LnGDPpc GovExp Unemployment Inflation Inequality Growth i.Year, re xttest0 Breusch and Pagan Lagrangian multiplier test for random effects Happiness[Nation,t] = Xb + u[Nation] + e[Nation,t] Estimated results: Var Happiness e u Test: sd = sqrt(Var) 1.413215 1876681 3933946 1.188787 4332067 6272117 Var(u) = chibar2(01) = Prob > chibar2 = 80.78 0.0000 51 Hausman test result (Happiness regressions) quietly xtreg Happiness LnGDPpc GovExp Unemployment Inflation Inequality Growth i.Year, fe estimates store fixed quietly xtreg Happiness LnGDPpc GovExp Unemployment Inflation Inequality Growth i.Year, re estimates store random hausman fixed random Coefficients (b) (B) fixed random LnGDPpc GovExp Unemployment Inflation Inequality Growth Year 2005 2006 2009 2012 (b-B) Difference sqrt(diag(V_b-V_B)) S.E .6358399 0186794 -.041183 0105508 0349247 -.0353075 8453409 -.010692 -.0572518 0001566 0286303 -.0452349 -.2095011 0293714 0160688 0103942 0062945 0099274 5186986 0212524 0175182 0043052 019131 0060571 4710144 -.0660077 -.0233256 -.5198696 2947871 -.2347638 -.3018519 -.7709841 1762274 1687561 2785263 2511145 1707999 2134579 2834694 3596653 b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg Test: Ho: difference in coefficients not systematic chi2(10) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 12.26 Prob>chi2 = 0.2682 (V_b-V_B is not positive definite) 52 Appendix Hausman test result (Changes in Happiness regressions) quietly xtreg DHappiness LnGDPpc GovExp Unemployment Inflation Inequality Growth i.Year, fe estimates store fixed quietly xtreg DHappiness LnGDPpc GovExp Unemployment Inflation Inequality Growth i.Year, re estimates store random hausman fixed random Coefficients (b) (B) fixed random LnGDPpc GovExp Unemployment Inflation Inequality Growth Year 2012 (b-B) Difference sqrt(diag(V_b-V_B)) S.E -36.88269 8095464 -2.365956 -.4467341 1.513595 -1.37077 -1.808591 -.0017136 -.7143736 1241001 -.1506338 -1.37419 -35.07409 81126 -1.651582 -.5708342 1.664228 0034198 41.32338 1.277187 1.039263 2534565 1.151056 4195309 -2.192301 -8.570025 6.377724 5.270261 b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg Test: Ho: difference in coefficients not systematic chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 23.62 Prob>chi2 = 0.0013 53 Appendix Indirect transmission channels with full large sample Dependent variable Constant Government Expenditure Ln(GPDpc) Adjusted R-squared Observations Unemployment 7.086 -0.081 (-0.20) 0.170** (2.45) 0.024 166 Inflation 19.439 -1.366*** (-3.29) -0.074 -1.07) 0.064 165 Inequality 59.267 -1.491 (-1.35) -0.523** (-2.33) 0.194 70 Growth 15.719 -1.209*** (-5.46) -0.067* (-1.83) 0.167 171 Clubs and Associations 0.541 -0.001 (-0.17) -0.002 (-1.37) 0.000 169 Intergroup Cohesion 0.329 0.033*** (5.99) 0.002** (2.56) 0.208 171 Interpersonal Safety and Trust 0.034 0.045*** (7.78) 0.001 (1.12) 0.272 169 Gender Equality 0.135 0.060*** (7.66) 0.004*** (2.71) 0.291 171 Inclusion of Minorities 0.231 0.024*** (5.98) 0.001* (1.92) 0.194 170 Notes: The t-statistics for the coefficients are in parentheses * 10% level of significance ** 5% level of significance *** 1% level of significance 54 Appendix List of countries (full sample) Afghanistan Bolivia Czech Republic Angola Brazil Germany Albania Barbados Djibouti United Arab Emirates Brunei Darussalam Dominica Bhutan Denmark Botswana Dominican Republic Algeria Antigua and Barbuda Central African Republic Australia Canada Austria Switzerland Azerbaijan Chile Burundi China Belgium Cote d'Ivoire Benin Cameroon Burkina Faso Congo, Dem Rep Bangladesh Congo, Rep Bulgaria Colombia Bahrain Comoros Bahamas, The Cabo Verde Bosnia and Herzegovina Costa Rica Argentina Armenia Belarus Ecuador Egypt, Arab Rep Eritrea Spain Estonia Ethiopia Finland Fiji France Gabon United Kingdom Cuba Georgia Ghana Guinea Cyprus Gambia, The Belize 55 Guinea-Bissau Kenya Myanmar Equatorial Guinea Kyrgyz Republic Montenegro Greece Cambodia Mongolia Grenada St Kitts and Nevis Mozambique Guatemala Korea, Rep Mauritania Guyana Kuwait Mauritius Hong Kong SAR, China Lao PDR Malawi Lebanon Malaysia Liberia Namibia Libya Niger St Lucia Nigeria Sri Lanka Nicaragua Lesotho Netherlands Lithuania Norway Luxembourg Nepal Latvia New Zealand Morocco Oman Moldova Pakistan Madagascar Panama Maldives Peru Mexico Philippines Macedonia, FYR Papua New Guinea Mali Poland Honduras Croatia Haiti Hungary Indonesia India Ireland Iran, Islamic Rep Iraq Iceland Israel Italy Jamaica Jordan Japan Kazakhstan Malta 56 Korea, Dem People’s Rep Suriname Tanzania Slovak Republic Uganda Slovenia Ukraine Sweden Uruguay Swaziland United States Seychelles Uzbekistan Russian Federation Syrian Arab Republic St Vincent and the Grenadines Rwanda Chad Venezuela, RB Saudi Arabia Togo Vietnam Sudan Thailand Vanuatu Senegal Tajikistan Samoa Singapore Turkmenistan Yemen, Rep Solomon Islands Timor-Leste South Africa Sierra Leone Tonga Zambia El Salvador Trinidad and Tobago Zimbabwe Serbia Tunisia Sao Tome and Principe Turkey Portugal Paraguay West Bank and Gaza Qatar Romania 57 Appendix List of countries (sub-sample used in Section 4.2) Angola Albania United Arab Emirates Central African Republic Canada Estonia Ethiopia Finland Switzerland France Argentina Chile Armenia China Australia Cameroon Austria Congo, Dem Rep Azerbaijan Congo, Rep Burundi Colombia Belgium Costa Rica Benin Cuba Burkina Faso Cyprus Hong Kong SAR, China Bangladesh Czech Republic Honduras Bulgaria Germany Croatia Bosnia and Herzegovina Djibouti Haiti Denmark Hungary Dominican Republic Indonesia Algeria India Ecuador Ireland Egypt, Arab Rep Iran, Islamic Rep Spain Iraq Belarus Belize Bolivia Brazil Botswana United Kingdom Georgia 58 Ghana Guinea Greece Guatemala Guyana Iceland Mongolia Russian Federation Israel Mozambique Rwanda Italy Mauritania Saudi Arabia Jamaica Malawi Sudan Jordan Malaysia Senegal Japan Namibia Singapore Kazakhstan Niger Sierra Leone Kenya Nigeria El Salvador Kyrgyz Republic Nicaragua Serbia Cambodia Netherlands Slovak Republic Kuwait Norway Slovenia Lao PDR Nepal Sweden Lebanon New Zealand Sri Lanka Pakistan Syrian Arab Republic Lithuania Panama Luxembourg Peru Latvia Philippines Morocco Poland Moldova Korea, Dem People’s Rep Madagascar Mexico Macedonia, FYR Mali Malta Chad Togo Thailand Tajikistan Trinidad and Tobago Tunisia Portugal Turkey Paraguay Tanzania West Bank and Gaza Uganda Romania Ukraine 59 Uruguay Venezuela, RB South Africa United States Vietnam Zambia Uzbekistan Yemen, Rep Zimbabwe 60 ... models which estimate the direct and indirect effects of government size on happiness The first model analyzes the direct effect following Pooled OLS, Fixed Effects, and Random Effects Models The second... SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS GOVERNMENT EXPENDITURE AND HAPPINESS: DIRECT AND INDIRECT EFFECTS A thesis submitted in partial... Development Index in the Fixed Effects and Random Effects regressions 3.3.2 Indirect effect model In order to capture the indirect effect of government expenditure on happiness, this research analyzes